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November 19, 2012

Capital Innovations’ ‘Wonderfully Boring’ Strategy

Michael Underhill of the Wisconsin-based firm tells the stark truth to clients looking for 10% returns, ‘it’s not the 1990s anymore.’

Maybe it’s easier to list where Michael Underhill hasn’t lived. In the course of his interview with AdvisorOne at Schwab Impact 2012 in Chicago on Thursday, he mentioned his time in London, San Francisco, New York, San Diego and Denver. Which is curious, since Capital Innovations, the firm he started in 2007 with partner Susan Dambekaln, is located in the decidedly non-financial hub of Pewaukee, Wis.

His cosmopolitan experience means he doesn’t mince words.

“Some of my clients will tell me they’re looking for a 10% annual return with no risk,” he said. “I say, ‘great, it’s not the 1990s anymore.’”

But it’s not as if he isn’t finding alpha for his clients in the fund he manages. He just does it in very defined areas.

“We are a firm that is equity-based and invests in real assets; specifically timber, agriculture and infrastructure in the Capital Innovations Global Agri, Timber, Infrastructure Fund,” he explained further.

Calling infrastructure “wonderfully boring,” he noted that it doesn’t matter if people are “happy or sad or in an up or down market, they still have to flush the toilet,” which makes infrastructure so relevant.

In agriculture, he argued the planet will soon reach a population of 9 billion people.

“To feed that many people, we'll need a 75% increase in the protein output. So we’re focused on companies that are able to increase crop yields.”

For instance, he pointed to an MLP play he’s in that invests in a company called Terra Nitrogen, which produces an alternative to potash. He said it’s more effective than potash with better economics.

“We made a 114% return in that MLP, which also gave us an 8% dividend yield,” he added.

He made a compelling case in general for commodity stocks, something in which the firm invests, as opposed to commodity futures, the more conventional point of entry for those looking to get into the asset class.

Employing an automobile metaphor, he noted that as an inflation hedge, commodity futures have proved effective 54% of the time between 1965 and 2007. Commodity stocks, however, have proven effective 76% of the time.

“If I have a car that only starts half the time, I’m not going to use it,” he explained. “I’d much rather use the one that starts three-fourths of the time. It will get clients further on down the road to their retirement goals.”

With agribusiness companies, the fund derives at least 50% of their gross income or net profits, directly or indirectly, from “the production, processing, and distribution of agricultural products, packaged foods, and meats, as well as the business operators and suppliers of equipment and materials.”

With timber companies, it derives at least 50% of their gross income or net profits, directly or indirectly, from the ownership, management or lease of forested land and harvest the timber from forested land for commercial use and sale of wood-based products, including lumber, pulp or other processed or finished goods such as paper and packaging. The companies include forest products companies, timber MLPs, timber REITs, homebuilding companies, paper products companies, and paper packaging companies.

Lastly, with the aforementioned “boring” infrastructure” companies, the fund derive at least 50% of their gross income or net profits, directly or indirectly, or have at least 50% of assets committed to providing energy, transportation, communications, utilities and other essential services to society. They include cable television, satellite, microwave, radio, telephone and other communications media; provision of transportation services, including toll roads, airports, railroads or marine ports; or provision of social assets, such as hospitals, schools, and subsidized housing.

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